The tax im­pli­ca­tions

Treat­ment of trans­ac­tion amounts as “in­ter­est” for tax pur­poses is con­strued as of­fen­sive

Finweek English Edition - - Money Clinic -

THE PRO­POSED new sec­tion of the Act brings three types of Is­lamic fi­nanc­ing trans­ac­tions within the tax net, re­mov­ing in­ter­est from the equa­tion, in­clud­ing:

Mudurabah: A form of de­posit where clients in­vest with the bank and, in turn, the bank in­vests their de­posits in Shari­ah­com­pli­ant en­ter­prises or prod­ucts. The prof­its are shared in a pre­de­ter­mined ra­tio be­tween the bank and its clients, who bear the risk of a loss on the in­vest­ments.

The bank earns man­age­ment fees and bears the risk of op­er­a­tional losses aris­ing from the ad­min­is­tra­tion of the ar­range­ment. Any profit de­rived by the client in con­se­quence of the in­vest­ment in the de­posit ac­count will, for tax pur­poses, be taken to

be in­ter­est.

Murabaha: A form of as­set fi­nanc­ing. The bank buys the as­set and pays the provider. The as­set is resold to the client by the bank at a mark-up and the client pays the bank in in­stal­ments. The bank’s mar­gin on the trans­ac­tion is cal­cu­lated by ref­er­ence to the in­ter­est that would have been raised on a con­ven­tional trans­ac­tion.

The bank’s mar­gin on the re­sale of the as­set to the client will, for in­come tax pur­poses, be treated as in­ter­est. For VAT pur­poses, the client will be taken to have bought the as­set di­rectly from the sup­plier at the price im­posed by the sup­plier. ( The bank buy­ing the as­set, and its re­sale to the client, will ac­cord­ingly be ig­nored for VAT pur­poses.)

A sim­i­lar ap­proach – a deemed di­rect ac­qui­si­tion of the prop­erty by the client, with­out in­ter­me­di­a­tion by the bank – will also be ap­plied for trans­fer duty pur­poses. Trans­fer duty will ac­cord­ingly be levied only on the orig­i­nal buy­ing price and not on the mark-up im­posed by the bank.

Di­min­ish­ing Mushasaka: A form of part­ner­ship com­monly used in the con­text of project fi­nanc­ing. The client and the bank jointly buy project as­sets; the bank’s share in the as­sets is di­vided into units and the units are pro­gres­sively bought by the client. For as long as the bank re­tains own­er­ship of the units, the client pays the bank rent on the un­sold units. The rent will di­min­ish as own­er­ship of the units passes to the client.

The bank’s units (own­er­ship in­ter­ests) in the as­set are leased to the client pend­ing the pro­gres­sive buy­ing of the units by the client. The rent paid on the bank’s units will, for in­come tax pur­poses, be taken to be in­ter­est.

For VAT pur­poses, the client will be taken to have acquired the as­sets at the out­set and di­rectly from the sup­plier at the sup­plier’s price. A sim­i­lar ap­proach will be adopted for trans­fer duty pur­poses.

While the treat­ment of trans­ac­tion amounts as “in­ter­est” for tax pur­poses might be con­strued as of­fen­sive, given the de­lib­er­ate avoid­ance of in­ter­est un­der Shariah pre­cepts, it should be ap­pre­ci­ated if the amounts in ques­tion were not to be treated as in­ter­est for tax pur­poses the client might be de­prived of the right to claim a tax de­duc­tion, even where a de­duc­tion would have been claimable pur­suant to a con­ven­tional fi­nanc­ing trans­ac­tion.

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